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FRONT PAGE CONTRIBUTOR

Cram Down the Investors of Chrysler LLC and Tesla Motors

And we have more expert coverage of the grand special-interest giveaway that is the automaker-bailout legislation currently being negotiated between the White House and Congressional Democrats.

The bailout contemplates a numerically-unspecified amount of public money to be donated to certain eligible automakers. You’re “eligible” if you filed a straw-man recovery plan in Congress on December 2. That means you’re either GM, Ford Motor, or Chrysler LLC.

And as I wrote earlier today, there is also a special handout of $500 million which seems tailored for a venture-funded electric-car startup named Tesla Motors, in Menlo Park, California.

I’ve already told you an awful lot about General Motors. Now I want to concentrate on Chrysler and Tesla.

Both of these companies are private, so we have no audited, public financial information to judge them by.

Chrysler has requested a grant of $7 billion in public money, to ensure its survival beyond the beginning of 2009. (I won’t call this a loan, because that would imply an expectation that we’ll get our money back. We won’t, certainly not if this pig of a bailout passes.)

All right, so let’s take Chrysler at their word. If they need that much money to survive, they’re in some pretty bad shape, right? Let’s assume so.

Who owns Chrysler LLC? Well, they’re 80% owned by Cerberus Capital Management LP, the private equity fund that bought Chrysler away from Daimler AG.
Cerberus is one of the largest, best-funded, best-managed, and candidly, most-feared private equity firms out there. They’re run by former Treasury Secretary Jack Snow, and there’s a who’s-who of well-connected former political honchos on staff too. This is a firm that can get nearly anyone on the telephone when they need to.

They also have quite a few billion dollars in undeployed capital available. Why don’t they put some into Chrysler?

Because Chrysler is not a company that any investor with a brain would put money into. THAT’S why.

And that’s why some of the wealthiest, smartest and most powerful investors in the world want they want the taxpayers, we who presumably are brainless, to put our money into Chrysler, behind theirs.

Now look at Tesla. This company was founded by Elon Musk, the billionaire founder of PayPal, and a technology and venture-capital hero.

Tesla is doing and has done terrific things. They’re committed to building fully-electric cars that people really want to drive. Well, at least people at a certain income level. Their roadster model has a six-figure price tag, and is said to perform at exotic-supercar levels, at least for the 40 or so miles that it will run on one charge.

I totally applaud what Tesla is up to. And I also applaud the fact that they have attracted large investments from some of the sharpest and best-connected venture capitalists out there.

The problem is that they’re nearly out of money now. In ordinary times, they wouldn’t have had much trouble attracting new capital from existing and new investors. But these aren’t normal times, and Silicon Valley is avoiding any new deals to the extent that they can.

But Tesla is a great idea, and might someday be a great company. It would be a shame for them to shut down now.

So naturally, their investors, who are some of the smartest and wealthiest people in the world, want YOU to come in and provide Tesla’s next round of funding.

That’s my interpretation of Section 9(a)(2) of the current draft bailout legislation. It’s a mysterious allocation of $500 million, with no recipient specified by name, for companies that are working on electric cars. Who else qualifies but Tesla, which recently asked the government for $400 million?

This is actually an impermissible deal under previous law, which stipulates that Section 136 loans may not go to companies that aren’t financially viable on their own. But given the star power (and the Democratic campaign contributions) of Tesla’s investors, do you think that will matter?

Ok, let’s cut to the chase. What does the draft bailout offer to taxpayers in return for bailout cash? It offers warrants for common shares equivalent to 20% of the bailout amount. There’s some vague language in there, which I don’t completely understand, to cover what is being warranted in the case of companies that don’t have publicly-traded common stock.

Since that can only refer to Chrysler and Cerberus, we have to ask how it would actually work.

I can tell you for darned sure that Cerberus isn’t going to be giving us warrants on 20% of $7 billion worth of their private equity. That equity is some of the most valuable stuff on earth.

Have you ever run a venture or private-equity funded company that had to do bridge financing or a funding round in a down market? I have. Let me tell you how this game is played.

Whenever a privately-owned company has to take on new capital on an emergency basis, the financing entity essentially names their own price. The standard practice is to negotiate as slowly as possible, until the company is days or hours away from going out of business, and then offering the financing so as to value the company at a few pennies on the dollar.

The existing investors usually get the opportunity to participate in the new round, pari passu with the new investors, and they will see their existing shares subordinated to the new shares.

In effect, the new investors cram the existing investors down to nearly nothing.

Now apply this to Tesla and Chrysler.

If we the taxpayers are going to provide emergency financing for these two privately-held companies, we need to insist on the standard deal structure.

To hell with 20% warrant coverage. We need to take senior convertible preferred stock, with an extremely high liquidation preference that will make all the existing stock essentially worthless. In Tesla’s case, I’d insist on a 25x or 30x liq pref. I’m deadly serious about this.

Again, this is how the game is played.

If we don’t do this, then I’ll tell you exactly what will happen next.

Chrysler LLC will be carried on the books of Cerberus as a breakeven. They’ll probably try to find someone else to buy it off them. These billionaires will come out of this without losing much, if anything. Is that what you, as a taxpayer, want to see?

The Tesla case is even worse. Let’s say they fulfill their promise to become the Ferrari or Lamborghini of electric cars, the playthings of the wealthy, and they go public someday.

The founders and early investors of Tesla will become billionaires. Whereas, without our help, they’ll fold now and lose everything they invested. Is that what you, as a taxpayer, want to see?